The Supreme Court has stayed the operation of an Allahabad High Court judgment holding that scrutiny of returns under Section 61 of the GST law is not an essential prerequisite for issuing a show-cause notice under Section 74A where the proceedings arise from independent verification suggesting that suppliers or subcontractors were bogus or non-existent.

A bench of Justice Pamidighantam Sri Narasimha and Justice Alok Aradhe passed the interim order, while hearing a special leave petition filed by assessee against the State of Uttar Pradesh and another respondent.

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The dispute arose from a show-cause notice dated July 9, 2026, proposing denial of input tax credit, together with tax, interest and penalty, on allegations concerning works purportedly subcontracted to 18 firms.

According to the supplied background material, the company is registered under the GST law and supplies works-contract services. It claimed to have undertaken substantial subcontract works for NCC Limited across Bihar, Jharkhand, Uttar Pradesh and Maharashtra.

The projects included excavation and diaphragm-wall construction for an irrigation project, development of electricity distribution infrastructure under the Revamped Distribution Sector Scheme, installation of smart prepaid meters and rural water-supply works. The company stated that individual contract values ranged from approximately ₹1.24 crore to ₹8.43 crore.

For the financial year 2025–26, portions of these works were allegedly further subcontracted on a back-to-back basis to 18 GST-registered contractors.

The company maintained that the transactions were supported by work orders, tax invoices, measurement sheets, completion records, banking documents, GST registration records, GSTR-2A details and B2B invoice summaries. It also relied on declarations from the subcontractors confirming execution of the works, receipt of consideration and payment of GST.

The department, however, alleged that the subcontracted works were bogus, the firms were non-existent and the company had wrongfully availed ITC using fictitious documents and invoices. These allegations formed the basis of proceedings under Section 74A.

The principal procedural issue before the High Court was whether the department could initiate proceedings under Section 74A without first scrutinising the company’s returns under Section 61 and issuing a discrepancy notice in Form GST ASMT-10 under Rule 99.

The company argued that the prescribed scrutiny procedure should have been followed before the department commenced adjudication proceedings. Its position was that an ASMT-10 notice would have enabled it to explain or reconcile the alleged discrepancies at the preliminary stage.

The High Court bench of Justice Shekhar B. Saraf and Justice Abdhesh Kumar Chaudhary rejected this contention. It held that Section 61 and Section 74A operate in separate fields and that return scrutiny is not the exclusive route through which the department may initiate proceedings concerning unpaid tax or wrongly availed or utilised ITC.

The High Court explained that scrutiny under Section 61 concerns verification of returns already furnished by a registered taxpayer. Such scrutiny does not itself result in confirmation or recovery of a tax demand.

Adjudication proceedings, on the other hand, may arise from information obtained through different sources, including scrutiny, audit, special audit, inspection, search, seizure or independent verification of suppliers and subcontractors.

A significant feature of the High Court’s reasoning was that the company’s returns had not been selected for scrutiny under Section 61.

The department stated that the show-cause notice arose from independent verification indicating that the 18 subcontractors were bogus or non-existent. On that basis, the High Court held that the obligation to issue an ASMT-10 notice under Rule 99 had not arisen.

The bench interpreted the expression “where it appears to the proper officer” in Section 74A as permitting action on credible information obtained from sources beyond return scrutiny.

At the same time, the High Court distinguished situations where the department relies solely on discrepancies in returns and has no independent source of information. According to the supplied background, it observed that compliance with Section 61 and Rule 99 may constitute a mandatory procedural safeguard in such circumstances.

The High Court also distinguished cases in which scrutiny proceedings had already commenced but the department failed to follow the prescribed procedure or properly consider the taxpayer’s explanation.

The company further contended that the provision dealing with fraud, wilful misstatement or suppression of facts had been invoked without the necessary foundational allegations.

The High Court found that the notice specifically alleged fictitious subcontracting arrangements, non-existent firms and ITC claims supported by fake documents. It considered those allegations sufficient, at the notice stage, to provide a foundation for invoking Section 74A(5)(ii).

However, that conclusion did not amount to a determination that the allegations were true.

The High Court treated the existence and functioning of the subcontractors, actual execution of the works and evidentiary value of the company’s records as disputed factual matters requiring examination by the adjudicating authority.

It drew a distinction between a notice lacking the foundational allegations necessary to invoke a statutory provision and a taxpayer disputing the correctness of allegations actually made. The latter, it held, required adjudication on evidence.

The company relied on the Calcutta High Court’s decision in Suncraft Energy Private Limited v. Assistant Commissioner, State Tax, arguing that ITC should not automatically be recovered from a bona fide recipient merely because a supplier failed to deposit tax.

The Allahabad High Court considered that reliance premature. It distinguished a case involving an existing supplier’s failure to deposit tax from a case in which the department disputed the very existence of the suppliers and the genuineness of the underlying transactions.

Whether the company could establish genuine supplies and invoke the protection claimed on that basis was therefore left to the adjudicating authority.

The supplied background also records that the company initially challenged the constitutional validity of Section 16(2)(c), but did not press that challenge during the High Court hearing.

The High Court declined to interfere at the show-cause notice stage, observing that the company had approached it without first submitting a reply to the department.

It held that the objections largely involved disputed facts and that intervention would prematurely interrupt the statutory adjudication process.

While dismissing the writ petition, the High Court permitted the company to file a detailed response within four weeks. It directed the adjudicating authority to consider the response independently, provide an adequate opportunity of hearing and permit the company to produce its work orders, invoices, measurement sheets, banking records, GST returns and other supporting documents.

The Supreme Court has now stayed the operation of that High Court judgment pending further consideration of the special leave petition.

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